In an opinion that could have led to catastrophic results for junior lien
holders, the United States Supreme Court issued a decision on June 1,
2015 that provides a resounding win for lenders nationwide.
Bank of America v. Caulkett (2015) 135 S.Ct. 1995, involved a borrower, David Caulkett1, who owned
a home with two mortgages against it, but the home's value was not
sufficient to satisfy the amount of even the first lien. The property
was valued at $98,000, but Bank of America's liens were $183,000 for
the first mortgage, and $47,000 for the second. The second lien was thus
Instead of filing a Chapter 13 bankruptcy and completing a 60 month prepayment
plan, the borrower tried to take a shortcut by filing Chapter 7 and then,
attempting to void a junior lien-something that is generally not permitted
in Chapter 7 bankruptcies. Generally,
United States Bankruptcy Code section 506(d) allows a bankruptcy debtor to void a lien on his real property
when it secures a claim against the debtor that is not both "allowed" and "secured." The Justices narrowly construed these two specific requirements
set forth in section 506(d), and determined that Mr. Caulkett can only
prevail if Bank of America's claim is either not allowed, or not secured.
Therefore, the Justices first needed to determine whether the claim was
allowed. All of the Justices agreed that it was; even the parties agreed
that the claim was allowed. The remaining issue, then became whether the
claim was secured. In true adversarial fashion of every litigated matter,
each side argued polar opposite positions.
Bank of America argued that its claim was obviously "secured"
within the meaning of the statute because it had a mortgage lien against
the borrower's real property. According to Bank of America, the existence
of the security interest alone (regardless of whether it could be paid
in whole or in part from the proceeds of a sale of the house), is sufficient
to undermine the debtor's attempt to void the lien altogether.
To the contrary, the debtor argued that the bank's claim is not "secured" because
Bankruptcy Code section 506 (a) (1) provides that, "[a] n allowed claim. . . is a
secured claim to the extent of the value of such creditor's interest
in . . . such property" and "an unsecured claim to the extent
that the value of such creditor's interest ... is less than the amount
of such allowed claim." Here, because the bank's security interest
in the property was essentially zero, the debtor argued that the plain
language of the statute automatically required the Court to rule in his favor.
The Justices, however, relied on a prior ruling in
Dewsnup v. Timm (1992) 502 U.S. 410, wherein the Court had already "adopted a construction
of the term 'secured claim' in section 506 (d)." In
Dewsnup, the Supreme Court rejected a similar argument by a debtor who sought to
strip down a partially underwater lien-an argument nearly identical to
the one that was now being raised by Caulkett. The Chapter 7 debtor in
Dewsnup sought to partially reduce her $120,000 lien to $39,000-the value of the
collateral-and thereby strip the lender's security interest down to
the property's current market value. The debtor in
Dewsnup also relied on the statutory definition of "allowed secured claim"
in section 506 (a) for the proposition that the lien was "secured
only to the extent of the judicially determined value of the real property
on which the lien [WA] is fixed."
After reviewing the language of the applicable statutes, the Court in
Dewsnup, determined that an allowed claim "secured by a lien with recourse
to the underlying collateral" cannot be voided under section 506
(d). Meaning, the Court would not consider the value of the property to
determine if a claim is secured; instead, the Court would focus solely
on whether or not the claim was "supported by a security interest
In Mr. Caulkett's situation, not only was Bank of America's claim
allowed, but it was also supported by a security interest against Mr.
Caulkett's real property. Therefore, the Court inculcate ruled that
the bank's lien could not be voided under section 506 (d).
The Court emphasized that the "constantly shifting value of real property"
could lead to "arbitrary results" if the Court were to adopt
and implement Mr. Caulkett's approach. For example, "[u] under
the debtor's approach, if a court valued the collateral at one dollar
more than the amount of a senior lien, the debtor could not strip down
the junior lien under
Dewsnup, but if it valued the property at one dollar less, the debtor could strip
off the entire junior lien." This "odd statutory framework",
as it was described by the Court, would lead to unpredictability in the
Court system. Therefore, even though the Court in Dewsnup only dealt with
a "partially" underwater lien 3, the exact same analysis must
be applied to all junior liens, even those like Mr. Caulkett's which
are "completely underwater." The Court inCaulkett, therefore, embraced and adopted Bank of America's approach and denied
the debtor's request to void the bank's junior lien.
This judicial decision completely eliminates a borrower's ability to
void underwater junior liens under section 506 (d) of the Bankruptcy Code.
This is excellent news for the lending industry as a whole, and for junior
lien holders in particular. Increasing a borrower's ability to strip
down or void underwater junior liens would ultimately cause lenders to
hesitate prior to making loans in a junior position, thereby reducing,
or even eliminating, the purchasing power of many borrowers. Moreover,
it could have caused many current lenders to lose their rights against
the property if their borrower files a Chapter 7 bankruptcy case when
market values are low. Such results would have devastated many lenders
who are currently in a junior position. Even though there are other ways
for borrowers to reduce or remove liens via the bankruptcy process, this
Case completely removes one potential avenue for borrowers, and that is
definitely a victory for lenders.
Caulkett decision was a consolidated decision regarding duplicative arguments raised
by two completely separate Chapter 7 debtors, David Caulkett and Edelmiro
Toledo-Cardono, both of whom had junior mortgage liens held by Bank of
America which were wholly underwater. For purposes of brevity, this Article
focuses on Mr. Caulkett and the value of his property and liens.
2The Court declined the debtor's request that the statutory definition
of "allowed secured claim" in Bankruptcy Code section 506(a)
be applied. Section 506(a) states that "an allowed claim of a secured
creditor secured by a lien on property . . . is a secured claim only to
the extent of the judicially determined value of the real property on
which the lien is fixed."
3The debtor owed $120,000 on the loan, but wanted to reduce the debt to
the value of the collateral securing that debt, which was only $39,000.